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Title:Explaining the favorite-longshot bias: Is it risk-love or misperceptions? PDF Logo
Authors:Snowberg, Erik
Wolfers, Justin
Issue Date:2010
Series/Report no.:CESifo working paper Empirical and Theoretical Methods 3029
Abstract:The favorite-longshot bias describes the longstanding empirical regularity that betting odds provide biased estimates of the probability of a horse winning - longshots are overbet, while favorites are underbet. Neoclassical explanations of this phenomenon focus on rational gamblers who overbet longshots due to risk-love. The competing behavioral explanations emphasize the role of misperceptions of probabilities. We provide novel empirical tests that can discriminate between these competing theories by assessing whether the models that explain gamblers' choices in one part of their choice set (betting to win) can also rationalize decisions over a wider choice set, including compound bets in the exacta, quinella or trifecta pools. Using a new, large-scale dataset ideally suited to implement these tests we find evidence in favour of the view that misperceptions of probability drive the favorite-longshot bias, as suggested by Prospect Theory.
Subjects:pricing under risk
probability
weighting
compound lotteries
favourite-longshot bias
JEL:D03
D49
G12
L83
Document Type:Working Paper
Appears in Collections:CESifo Working Papers, CESifo Group Munich

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